Two

RESISTANCE

Why Frictions Exist and

How to Overcome Them

RE
r
SIS
r
TANCE n.
A force that tends to oppose or retard motion.

In chapter 1, GEOGRAPHY, we saw that the real world is organized in

a structured way. Individuals choose where and how to live, and these
choices lead to specific neighborhood clusters. That is, neighborhoods
tend to be formed by people who share demographic characteristics,
lifestyles, and preferences for certain types of goods and services. Birds
of a feather do indeed flock together.
More than this, people who are in close (physical) proximity to one
another tend not only to consume similar products and services, but
also to share information about the things that they like. My friend and
neighbor Lee often tells me about new bars and restaurants in Philadel-
phia; colleagues at work chat about the latest gadgets.
In this chapter, Ill look at how we navigate the real world and what
that means for how we enlist the virtual world to help overcome fric-
tions and get what we want.

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Real-World Frictions

THE DIFFICULTY OF SEARCH

In the real world we all face obstacles to getting what we want. Markets
dont always provide us with exactly what wed like to know to make
an informed choice, or exactly the right product for our needs and
desires let alone at the right price.
These kinds of impediments are quite stubborn and persistent, and
they have been around forever. Well use some helpful jargon and refer
to them as frictions.
This term really gets to the nature of these obstacles they dont ab-
solutely prevent you from doing things, but they do make your life more
difficult. Youve undoubtedly encountered them, and you have perhaps
even tried to overcome them (or at least thought about how to do so).

A Fraction Too Much Friction

I am going to focus mainly on the two most pervasive and common

frictions, although Ill mention one or two others along the way as
well.
The first is search friction, or the inability to get the information
that you and I would like to have before making a decision. We are al-
most always better off having more information, such as more informa-
tion about the prices we might expect to pay at certain stores, about the
quality of food in restaurants, and about the experiences of others with
local merchants and service providers.
Not surprisingly, economists have been studying search for a long
time now (its one of their most popular pursuits), so we know quite a
bit about it. To see how this friction works in practice, imagine that its
1987 and you want to buy a big-screen TV so you can watch the inaugu-
ral Rugby World Cup Final in Auckland, New Zealand.

1 For those who like trivia, the finalists in this game were France and New Zealand, and the

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Since were back in 1987, the Internet cant help you.

So you visit a local store and start to gather information about the
prices and qualities of different sets. The set that you like is fairly pricey
but you know there is another store across town that might have a bet-
ter deal. At this point, you can either buy the set in front of you or drive
across town to another store to see what they have.
Of course, to get across town youll have to burn gas and time i.e.,
incur search costs for the possibility that you will get a better product or a
better price on the product that you are currently considering. The other
store might have higher or lower prices, or a better (or worse) selection
than the current store. Beyond this, its impossible to know exactly what
will be in stock. So, if you leave the bird in hand and traipse across town
to the alternate store, you just dont know what youre going to get.
When I said that studying issues concerning search was a popular
pursuit for economists, I wasnt joking. A Google search using the term
economics of search turns up just over 500 million references!
This whopping number aside, the basic finding from the core aca-
demic literature is insightful: we keep searching for additional informa-
tion until the expected costs of searching exceed the expected gains.

Formal Search: Looking for a TV in the Real World

Lets continue with the TV example and imagine that the following hap-
pens: Youre still standing in your local store, staring at the price tag.
Kickoff time is fast approaching. You figure that it will take thirty min-
utes to drive across town and, based on past experience, decide that al-
though theres a small chance the price will be better, any savings will be
negligible.

same teams met twenty-four years later in the 2011 Rugby World Cup Final with the same
result.
2 Come to think of it, big-screen TVs might not have been around either in 1987, but lets just
proceed with our scenario.
3 The word expected is very important here. It reflects the fact that you just dont know for
certain what youre going to find, should you decide to keep searching. Your expectations
come from past experiences, advertising, and so on (as I illustrate next with the TV-buying
example).

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On balance, you decide that its not worth the trip, so you take out
your credit card and (fairly) happily spend $1,995 on your new Sony.
In this instance, the expected costs of additional search exceeded the
benefit, so you stopped searching and started buying. Way back in the
1960s, the Nobel laureate George Joseph Stigler formalized this idea in
his article The Economics of Information. Were the expected benefit
of continued search higher than the cost, you would take the additional
trip and go to a second store.
Also, it pays to keep in mind that since different people in the real
world value their time and money differently, its quite likely that some-
one else faced with exactly the same outcomes would have taken the
extra shopping trip.
So what does this show?
The real world has an important and pervasive friction. You have to
expend effort incur search costs in order to make better decisions.
This could entail searching for better prices on consumer electronics
or groceries, or even shopping around for a better person to date. The
virtual world is a big help, so enter Milo.com, the SaveOn! app, and
OKCupid.com to solve the electronics, groceries, and dating problems,
respectively.
In fact, there are literally thousands of new businesses and innova-
tions on the Internet that have arisen to help mitigate the broadly de-
fined problems of search. This is actually no surprise, considering how
valuable it is to consumers for such search problems to be solved.
Later in this book well look at TripAdvisor.com a business now
valued at several billion dollars. TripAdvisor.com started as a small
startup business and essentially exists thanks to you and me providing
all its content.
For free.
So, I suspect there are still hundreds (if not thousands) of possibili-
ties for new virtual-world businesses that will eliminate some of the
real-world search frictions we all encounter every day.
Perhaps youll start one of them.

4 George J. Stigler, The Economics of Information, The Journal of Political Economy 69,
no. 3 (June 1961), pp. 21325.

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MORE FRICTION: THE TYRANNY OF GEOGRAPHY

Take a look around the town or neighborhood that you live in. When
it comes to location, size matters for two reasons. First, bigger markets
(e.g., New York City, Los Angeles, and Chicago) have more people, and
therefore more total demand and consumption needs and selection,
than do smaller places (e.g., Sioux Falls, Iowa City, and Durham).
As a result, theres just more stuff around in places that are bigger.
For some people, that variety, or at least the value of having options
available that comes with it, makes big cities attractive places to live in.
Second, theres a higher chance there will be more people nearby like
you when you live in a bigger city. Why, reasons of ego aside, does this
matter? I explore this in more detail in chapter 5, ISOLATION, but when
there are more people like you, theres a better chance that youll get the
things that you want.
Heres a quick preview.
Assume that you like corn beef hash (who doesnt?). If the chef at
your local caf believes that there are enough people in total in your
neighborhood who like it, he or she might put it on the menu and make
it available for breakfast. (Nice as you are, shes not making it just for
you!)

Designer Jeans in Iowa, and Diapers (Again)

The Internet, however, is a great enabler for people who live in smaller
markets. They can be released from the tyranny of geography simply
by finding and ordering what they need online. If you want designer
jeans that arent available in the stores in Sioux City, you can simply go
to Bluefly.com and order them.
This is how the Internet solves what Ill call geographic friction
number one you can live in Sioux City (a small market) but still have
access to New York City (big market) variety.
Geographic friction number two is a little more nuanced. Even peo-
ple in New York City may not get quite what they want, if what they
want is a bit narrowly defined and there arent enough others like them.

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When the market is too small, no profit-seeking commercial provider

will actually step in and offer something.
Of course, for certain types of products and services, the government
will get involved, ensuring that things exist like broadband Internet in
rural areas and libraries in small towns.
The Internet liberates everyone by aggregating people, independent
of their location, and creating a large, addressable market. Well explore
this aggregation idea in detail in the next three chapters, but heres a
window into how it works.
Think back to Diapers.com. Would Marc and Vinnie have been as
successful (or even had any success at all), if they had opened diaper
stores throughout the United States?
Answer: probably not.
The reason? No matter how many babies there are in a certain lo-
cation, its unlikely that there are enough people to support a business
that sells just diapers. On the other hand, if there are even a few people
in each zip code whod like to buy diapers and related products online,
that quickly adds up to a lot of people! In this example, the Internet
has liberated those who are different from those around them (even if
they happen to live in a big city).
So the Internet creates markets made up of similar people, inde-
pendent of where they actually live.
Think about that for a moment. Its a pretty powerful idea. We
have only one physical world, and it pretty much stays put (the shift-
ing of tectonic plates aside). Now with the Internet we can create any
number of virtual worlds. A world of people who follow and discuss
rugby? Sure, Rugby365.com. A world of people who need diapers for
their newborns and who would rather not shop for them offline? Enter
Diapers.com.
The key, of course, is that each virtual world can be impacted in dif-
ferent ways by the single, and relatively constant, real world.

5 For more examples of situations in which the government steps in (and why), see Joel
Waldfogels excellent book The Tyranny of the Market: Why You Cant Always Get What You
Want (Boston: Harvard University Press, 2007).

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Overcoming Search and Geographic Frictions

GETTING WHAT YOU WANT

So the Internet removes, or in many settings at least substantially miti-

gates, the two most intransigent and enduring market frictions. With
it, you can find out the price of almost anything without leaving your
house, connect with almost anyone, and buy pretty much whatever you
like no matter where you live so long as someone is willing to deliver
it to you.
And you can do all this from anywhere if you have your smartphone
in your pocket. (In chapter 6, Ill share a lot about how these frictions
change when you and I use mobile devices versus laptops and desktops.)

Buying Stuff and Going Out

There are specific ways that we actually use the Internet to overcome
frictions as a function of where we live. Well discuss both products and
information in this regard, but lets start with products, as this is a bit
more intuitive.
If you live in New York City and I live in Iowa City, then, for me, the
Internet makes up for the absence of a variety in local products. I can
source designer jeans, organic household cleaners, and almost anything
else through the miracle of the Internet. In short, the Internet acts as a
substitute for the lack of variety at local stores.
You live in New York City, so your fashion shopping gets done in
SoHo and household staples (even organic ones) can be picked up at any
of the numerous Duane Reade drugstores, Whole Foods stores, and the
like. Sure, you can shop online too, but for you, the need to do so is not
urgent, because your local market already addresses most of your needs.
Now that weve seen what happens with products, lets turn to infor-
mation. There are an overwhelming number of bars, restaurants, events,
and activities in New York City. Wading through them all is quite dif-
ficult, perhaps even impossible. (It certainly would not be feasible to try

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to eat in every single restaurant in the city.) Hence, information about

what is going on and where and whats worth checking out is very
useful to you.
As a result, those of us who live in large cities tend, on average, to be
heavier consumers of local information. The Internet complements the
existing goods and services already in abundance providing large-city
dwellers with information that enables them to navigate all of the ac-
tivities in their variety-laden locations.
Now of course both New Yorkers and Iowans buy things online and
use the Internet for information too. What matters here is the relative
emphasis. People in locations with less product variety and selection are
more apt to turn to the Internet for goods. People in locations that offer
an abundance of things to do turn to the Internet for information about
how to enjoy them.
Academic studies have calculated just how important and numeri-
cally significant these effects are.

Dollars Per Mile

Central place theory (CPT), as mentioned in chapter 1, formalizes the

idea that bigger markets bring about more variety of goods and services
than smaller markets do. And beyond that, CPT states that there are
certain natural thresholds for offerings. For example, if you live in a re-
ally small town, there might only be one supermarket and one gas sta-
tion. If the town grows a bit, one more of each might spring up to ac-
commodate the increased demand.
This concept is easy to understand when we think about physical
goods and services, but as Ill show in a moment, it turns out to be true
for information (or content) too.
So, how exactly does an offline deficit in goods push you to go
online?
Well, all else being equal, the farther away you live or work from a
particular offline seller, the less money youll spend there. If the seller is
too far then you wont visit it at all.
This is retail or commerical gravity at work again.

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Relatedly, the farther you have to travel to reach particular offline

stores, the more likely you are to shop online. For example, if Wal-Mart
is too far away, youre more likely to go to Soap.com for your detergents
and household cleaning supplies.
For every extra mile that you must travel to visit a physical store,
the greater the chance that you buy the item youre seeking online. One
study by researchers at the University of Pennsylvania found that if you
move from one mile away to five miles away from the nearest store, the
gap between your online and offline spending increases by about three
percent. This is actually a pretty big effect!
Heres one final point about the difference between small towns and
large cities.
Because of Tiebout sorting, as discussed in chapter 1, its quite likely
that people whove chosen to live in smaller places just have lower con-
sumption needs to begin with. In fact, thats almost always the case.
The Tiebout explanation is quite subtle. People who live in smaller
locations have chosen them for a reason. Perhaps they have less inher-
ent need for access to wide variety of local goods and services, or per-
haps they have less income, or both. Regardless, on average, and for
people in small towns especially, living a greater distance from physical
stores increases a persons chance of shopping online.

Sites Per Million and Traffic Patterns

Traveling long distances to buy goods is something that wed all rather
be able to avoid doing; naturally, wed like everything to be close by. This
is what retail gravity is all about. Quite surprisingly, there are also pat-
terns to be found in how far we are willing to travel for information.
Consider popular national websites like ESPN.com and CNN.com
and ask yourself: Where do their customers come from? In a sense

6 Todd Sinai and Joel Waldfogel, Geography and the Internet: Is the Internet a Substitute or
Complement for Cities?, Journal of Urban Economics 56, no. 1 (July 2004), 5674.
7 In case you didnt read chapter 1 or have forgotten what you read, Tiebout sorting refers
to the fact that you and I sort into (or choose) neighborhoods that have the right mix of
costs and benefits for us; e.g., high property taxes but excellent public schools.

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there is really no distance or gravity involved in visiting a virtual lo-

cation like ESPN.com. Its the same number of keystrokes away whether
you live in Iowa City or LA. Hence, national sites such as ESPN.com
and CNN.com draw traffic numbers from physical locations that are
roughly proportional to the sizes of the populations of those cities.
Los Angeles has about 3.8 million residents and Iowa City has about
70,000, so that means LA is around 55 times as big. Given this, we may
assume that the national sites SI.com (sports) and CNN.com (news)
will have approximately fifty times as much traffic from LA as they do
from Iowa City.
Now, in addition to national sites, of course, there are also myriad
local ones such as PhillyToDo.com and LATourist.com, as well as nar-
rower sites, like NorthernLiberties.org (which addresses the goings-on
in the Northern Liberties section of Philadelphia) or Weho.org (focused
on West Hollywood in Los Angeles). The sheer number of these kinds
of sites and their traffic patterns are also explained by their users physi-
cal locations.
To see what happens here, lets first focus on the number of local
sites.
Research shows that the larger the city, the more local sites there are
that serve up content devoted to the people, places, and activities that
define it. One study found that adding an additional one million res-
idents in a US Metropolitan Statistical Area (MSA), an area that can
cover more than one city, brings forth about another 5060 sites de-
voted solely to content pertaining directly to it.
Back in the 1930s, way before the virtual world even existed at all, CPT
told us that in the real world the supply of goods and services increases
along with the population. Moreover, Reillys retail gravitation model
told us that physical stores have fixed trading areas, beyond which they
have no hold over customers. So its fascinating to see, more than eighty
years later, how these ideas have a similar message about the production
and consumption of information in the virtual world as well.
As weve established, larger cities have a greater number of sites de-
voted to them, and the amount of traffic that a national site such as

8 Sinai and Waldfogel, Geography and the Internet.

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ESPN.com gets from a given location is roughly proportional to the

population in that location. The patterns for local sites however, are
quite different. (Hint: keeping thinking about our principle of gravity
the farther away you get from a particular good or service location, the
less likely you are to use it.)
PhillyToDo.com generates almost all of its traffic from people resid-
ing within the greater Philadelphia area. Thus, a local site serving up in-
formation is a bit like an offline store selling goods. Retail gravity plays
an important role. Its still more important for physical stores than it is
for virtual sites no one will drive from Philadelphia to buy groceries at
the Ralphs supermarket in West Hollywood, but some West Hollywood
residents may be inclined to travel to PhillyToDo.com if theyre plan-
ning an upcoming trip to the City of Brotherly Love.

Buying Coffee Makers Online

Some really fascinating and counterintuitive things unfold when real

worlds, virtual worlds, products, and information are all combined as
part of an overall shopping option for consumers.
Lets dig into an example.
Specifically, lets consider what happens when a store offers you
BOPS. Not sure that you want this painful-sounding service? Relax, its
just another retail acronym it means Buy Online, Pick up in Store.
When a store offers BOPS, you can go online and check out, say, a new
espresso maker or a duvet, buy it, and then wander by the store and pick
it up from there.
Lets look at all the ways this option helps you. You can reduce your
search friction because you know the price of the espresso machine, and
you also know that its in stock (if it wasnt in stock the store wouldnt
give you the option of picking it up). On top of that, you dont have
to deal with a major pain point of online shopping: waiting for that
package to arrive with your new shoes, duvet, coffee machine, or what
have you.
This is an important issue for shopping in the virtual world, so lets
take a short detour and explore a key research finding. George Low-

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enstein at Carnegie Mellon University conducted a clever study with a

series of three experiments to measure just how annoying waiting is.
The subjects in the experiments were exposed to hypothetical pur-
chases of VCRs (remember them), gift certificates for restaurants, and
gift certificates for local record shops (remember them as well?) and
told that their purchases would be delivered to them in a set time pe-
riod. Subjects in a delay condition were asked how much they would
need to be compensated for the inconvenience of an unexpected two-
day delay. Other subjects were told that their shipments could actually
be expedited if they so desired. They were asked how much they would
be willing to pay for the delivery to be expedited.
So, one group has to be paid for a two-day delay and another is asked
to pay for a two-day speed up.
In each experiment, the subjects in the delay group wanted more
compensation than those in the expedited group were willing to pay,
even though the amount of time involved was exactly the same for both
groups. This phenomenon was coined the delay premium, and means
that you and I need to be paid more to have to wait longer than ex-
pected, compared with how much wed be willing to pay to shorten the
wait time by the same amount.
So in some sense, BOPS gives you the best of both worlds (full infor-
mation before purchase and no waiting for delivery, although you do
of course have to stop by the store to pick the thing up). As a side note,
geographic friction doesnt really apply in this example to the extent
that the store is at least offering you a decent selection of coffee ma-
chines and other products that youre interested in.
Santiago Gallino at Dartmouth College and Toni Moreno at North-
western University dug into the effect of BOPS and analyzed the sales

9 For details, see George F. Loewenstein, Frames of Mind in Intertemporal Choice, Manage-
ment Science 30, no. 2 (February 1988), 200214. Some shoppers also take note of whether
the prices they see in stores are favorable, compared with what they recall from their last
shopping experience. When they are favorable, consumers accelerate their purchases, and
when theyre unfavorable, they delay them. For details, see David R. Bell and Randolph
Bucklin, The Role of Internal Reference Points in the Category Purchase Decision, Jour-
nal of Consumer Research 26, no. 2 (September 1999), 12843.
10 Throughout the book Ill continue to use the term geographic friction to mean that a spe-
cific location is trapping customers by not giving them enough variety.

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data for a major US retail chain specializing in housewares and with

more than eighty stores. One very nice feature of the study is that the
chain had stores in both the United States and Canada, and the BOPS
option was offered only to shoppers in the former. Gallino and Moreno
could then see what happened to sales in the two countries one that
had BOPS and one that didnt.
After BOPS was made available to US consumers, Moreno and Gal-
lino expected to find that online sales in the States would go up. US
shoppers should be much more willing to buy online now that they
could do so without the downside of waiting for their stuff to arrive.
Surprisingly, that didnt happen at all.
Online sales went down.
Yes, thats right. Online sales went down, even though website traffic
went up.
So, what happened? Well, the explanation for this paradox relates to
one final friction that applies when certain kinds of goods are avail-
able online.
Ill give the details in a moment but a little historical segue helps here.
In 1994 Jeff Bezos founded Amazon arguably one of the most bril-
liant innovations in retail. (And Im not just saying that because Ama-
zon is publishing this book!) At that time, not much was being sold on-
line at all; however, there had been a rather large catalog business in the
United States for the best part of the past one hundred years.
So what product category, in 1994, was the leader in catalog sales?
(Clue: it wasnt books.)
It was apparel.
Why didnt Jeff Bezos start selling apparel online at Amazon right off
the bat? Because he realized that apparel might not be the best fit to the
new medium of the Internet.
The reason?
Most of us like to try clothes on before buying them. Clothes have

11 Santiago Gallino and Toni Moreno, Integration of Online and Offline Channels in Retail:
The Impact of Sharing Reliable Inventory Information, Management Science (forthcoming).
12 This works as a sort of natural experiment, in the sense that one group just so happened
to experience something that the other did not. As such, its an ideal approach for teasing
out how particular interventions affect behavior or other outcomes. We will see a few more
examples later in this chapter.

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tactile, or touch and feel, attributes that are hard to communicate on-
line. Jeff Bezos rightly recognized that this would be a barrier to pur-
chase, so he went way down to the twenty-fifth most popular product
category sold at the time via catalogs: books. They were a perfect fit
for the Internet. There is nothing about a book that you really need to
touch and feel. If you know the price, the author, what its about, and
perhaps a bit of information from reviews, then youre good to go.
Now, back to the present.
Moreno and Gallino realized that the same kind of thing was hap-
pening with BOPS, since most of the products sold by the retailer they
studied housewares, home accessories, furniture, and related items
also had touch and feel attributes.
Traffic at the website was up because shoppers could go online to get
price and in-stock information before buying (the Internet had reduced
their search friction), but they still wanted to turn on the coffee ma-
chine, sit on the sofa, or touch the duvet before buying.
So they didnt actually buy what they wanted online. Having con-
firmed the price and that the item was in stock, they went to the store to
inspect the product. Hence, sales at the store went up.
The nice insight here is that the virtual world removed some of the
frictions (i.e., knowledge of price and in-stock position) but not all of
them. The real world still had a role to play because shoppers wanted to
sample the products before buying them.
Nevertheless, BOPS was a great success because it led to wait for
it ROPO (Research Online, Purchase Offline).

13 Without wanting to confuse things, I should introduce a little more marketing terminol-
ogy. This jargon is helpful for our discussion in this book and beyond, so please bear with
me. Academics refer to three different kinds of products and product attributes: search,
experience, and credence. The first term is a bit confusing, given the way weve already used
search, but here goes: A search good is one for which you know exactly what you are going
to get, even before you buy it. Think of Dunkin Donuts coffee. (Of course, this presumes
that youve already purchased the coffee before in a real-world location.)You know how
it will taste before you order it. Theres no surprise. Experience goods on the other hand
are those for which you dont really know what youre going to get until you start touch-
ing, feeling, or consuming them. Examples are mens suits and even MBA degrees. With
credence goods, you often still dont know how you feel about them even after youve con-
sumed them. Surgery and management consulting are examples. You paid for your surgery
or consulting report, and yet you still dont know whether the surgery worked (although
you might feel OK) or whether the advice was any good (although the consultants had
fancy degrees and were always nicely dressed).

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Amazon in the Virtual World Versus Booksellers

in the Real World

Common occurrences when shopping for everyday products also af-

ford us a nice window into how the real and virtual worlds interact.
Most of us have bought a book from Amazon, and quite a few of us have
shopped for books in a Walmart or a Barnes and Noble. So, imagine
that youve been buying your books from Amazon and also that there
are no physical bookstores near you. Now, lets see what might happen
if Barnes and Noble suddenly opens a bookstore in your neighborhood
just a few blocks away. Will your access to this new store change your
book-buying habits on Amazon.com?
Well, for starters, you now might immediately be able to satisfy your
craving to read. You can potentially get the book you want by just going
down the street to the bookstore.
Researchers in the United States and Canada discovered there was a
neat twist to how this happens.
Say that you want a copy of Harry Potter and the Sorcerers Stone to
read on your Fourth of July vacation you might now just go directly to
Barnes and Noble to get it. As a result, Amazon.com starts to lose sales
on Harry Potter in the zip codes around the area where the new store
has opened. Again, because sales at physical stores are subject to com-
merical gravity, Amazon.com will not lose sales in zip codes that are
more distant from the new store, since by definition they are outside the
trading area for the store.
If your reading tastes lean a little more eclectic say you want to
read Richie McCaw: The Open Side then Amazon.com isnt likely to
suffer. This is because youre going to think twice about trudging to the
store to buy this particular book.
Why the difference?
Well, when an item is as popular as the Harry Potter book most
certainly is, then Barnes and Noble a store with limited space will
make sure to stock it. Thanks to this fact, you can happily wander over
to Barnes and Noble, safe in the knowledge that the book will almost
14 Chris Forman, Anindya Ghose, and Avi Goldfarb, Competition Between Local and Elec-
tronic Markets: How the Benefit of Buying Online Depends on Where You Live, Manage-
ment Science 55, no. 1 (January 2009), 4757.

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surely be available and that your craving to read it right away will be
met.
When the item is rarer or a niche product (as a Kiwi, I cant bring
myself to deem any book about our national game, rugby, or an All
Black captain as unpopular), youll make a different choice. You will
(rightly) suspect that its not really in the interests of the store to carry a
book that doesnt have broad appeal. Youre safe to bet that the product
will not be available offline.
It will, however, probably be accessible from Amazon in a single
click.
This is why sales of popular items at Amazon.com will go down
in zip codes contained in the trading of the new store after it opens,
but sales of niche items will not. Beyond this, Amazons discounts will
be less effective Amazon has to do more to get your business once a
physical competitor enters your market. Once again, the characteristics
of the physical world have an important sway over shopping and selling
in the virtual world.

Gravity and Cross-Border Trade in Goods and

Information

The Noble laureate and popular New York Times columnist Paul Krug-
man is a pioneer in the academic field of economic geography, and his
core ideas are quite relevant for our discussion. A key one is that in-
ternational trade between countries is shaped by gravitylike principles.
(Yes, gravity again!)
Specifically, trade is less likely when countries are far apart and when
their economies are of relatively disparate sizes. Trade is more likely
between countries that are close geographically and similar in size
economically.

15 As you might imagine, Amazon of course carries considerably more titles to begin with.
Some researchers at MIT calculated that the entry of Amazon into the book market led to
significant gains for consumers in terms of access to variety. See Erik Brynjolfsson, Jeffrey
Hu, and Michael Smith, Consumer Surplus in the Digital Economy: Estimating the Value
of Increased Product Variety at Online Booksellers, Management Science 49, no. 1 (January
2003), 158096.

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Again, this is largely due to frictions New Zealand and the United
States not only are far away from each other but also have very different
size economies (the United States has the largest economy of any coun-
try; New Zealand is much further down on that list).
There are generally significant travel frictions between the two coun-
tries, and greater disparities in business cultures among countries of dis-
parate sizes. Thus, a simple application of commercial gravity suggests
that there should be more trade between and Australia and New Zealand
and between the United States and Canada than there is between the
United States and New Zealand.

VIRTUAL-WORLD GRAVITY

Its pretty obvious that trade in physical goods, which have to be moved
around, would be constrained somewhat by the distance between trad-
ing partners. And this is especially true for things that are heavy, bulky,
expensive, and just plain hard to move. Researchers at the University of
Chicago discovered a nice parallel fact when they looked at sales being
transacted online. They found that goods with a high value-to-weight
ratio were the most likely candidates to be sold via e-commerce.
Now lets push our intuition a bit and try to imagine whether virtual
goods would be affected by distance in the same way.

Why Americans Get Rugby News from South Africa

and Pornography from Canada

Imagine that you live in Philadelphia and are interested in hardy sports.
(If you live in Philadelphia, then you certainly need to be a hardy fan,
given the typical performance of our pro teams.)

16 I am, however, happy to report that New Zealand is, according to the Economist, number
one on the corruption index (i.e., the least corrupt country and, of course, less corrupt than
neighboring Australia is).
17 Ethan Lieber and Chad Syverson, Online Versus Offline Competition, in The Oxford
Handbook for the Digital Economy, ed. Martin Peitz and Joel Waldfogel (New York: Oxford
University Press, 2011), 189223.

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Lets say that you are interested in rugby in particular.

RugbyHeaven.com (hosted by the Sydney Morning Herald) is an op-
tion for content, as is Rugby365.com, based in Cape Town. Each site is
just a click away, but Australia is a bit farther from the United States than
South Africa is. So, to which site will you, our intrepid rugby lover, go?
Incredibly, it turns out that content on the Internet is subject to the
laws of gravity as well, even though there are no apparent travel costs.
(Of course, we need to control for the obvious effect of language even
if you live in San Diego, you are unlikely to visit the website of the
Spanish-language El Sol de Tijuana if the full extent of your Spanish is
Yo no hablo espaol.)
A clever study by researchers in Canada examined this issue by look-
ing at the country of origin of over nine thousand sites visited by US
consumers. The sites were hosted in thirty-seven different countries
alphabetically from Australia to Slovakia (yes, New Zealand was in-
cluded too) and covered a range of different types of content, from
software to games to music.
It may not come as a revelation to know that for fourteen of the
thirty-seven countries, the most popular content category visited by US
citizens was pornography! In fact, it was the only thing from Hungary,
Indonesia, and Luxembourg that this particular sample of US surfers
consumed.
Surprisingly, and counter to our likely instinct that distance should
have no impact on consumption of content, the authors of the study
found that, on average, for every 1 percent increase in the distance be-
tween the country that you live in and some foreign place, theres a cor-
responding 2 percent decrease in the chance that you will visit a site
hosted in that country. This effect of distance holds after controlling
for (or eliminating) the effects of language differences and demographic
factors.
Now, this average effect has some interesting nuances. When con-
sumers have to pay for the content, information, or goods, the deterring
effect of distance on travel to a foreign website for content strengthens
to 2.7 percent; when these things are free, the deterring effect weakens

18 Bernado Blum and Avi Goldfarb, Does the Internet Defy the Law of Gravity? Journal of
International Economics 70, no. 2 (December 2006), 384405.

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and declines to 1.1 percent. But perhaps the most interesting nuance is
the difference between taste-dependent categories (gambling, games,
music, and pornography) and non-taste-dependent categories (ency-
clopedias, software and technology information, and financial content).
For non-taste-dependent categories, distance doesnt matter at all;
i.e., there is no statistically significant effect of distance on consumers
behavior. US consumers are just as happy getting financial information
from Australia as they are getting it from South Africa.
Not so for taste-dependent categories, where the deterring effect of
distance on travel to foreign websites is a whopping 3.5 percent for
every 1 percent further the host country is from the US. Now in the
interests of taste, Ill move away from pornography (the most popular
category of foreign content overall for US citizens) and instead consider
rugby chat as a cultural or taste-dependent product category for the
purposes of an example to illustrate the point that I just made.
The distance between Philadelphia and Sydney is about 9,100 miles,
and the distance between Philadelphia and Cape Town is about 7,800
miles. Getting to Sydney involves about 17 more distance to travel.
So, whatever chance our Philly rugby fan has of going to Rugby365
.com (hosted in Cape Town, South Africa), he is more than 50 per-
cent less likely to go RugbyHeaven.com (hosted in Sydney, Australia)!
This is because Sydney is about 17 percent farther away and each
percentage point reduces the likelihood by 3.5 percent, for a total of
51.5 percent.
What makes this so interesting is that there is literally no additional
cost or travel time to clicking on a South African versus an Australian
site about essentially the same thing.
The theory underlying this finding is that the closer that creators and
users of content are to each other in the real world, the likelier they
are to have similar interests or tastes. This means that the consumers
of content people like you and me are more comfortable getting our
content from sites hosted in places that are physically closer to us. Dis-
tance is a proxy for cultural similarity.
Theres actually a nice parallel here to our Folgers in San Francisco
and Budweiser in St. Louis story from the last chapter. There we learned
that location matters a lot in our choice of undifferentiated products.
And here we see that it seems to matter for content that is at least some-

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what generic as well. Believe me, there isnt that much difference be-
tween the news at Rugby Heaven (www.smh.com.au/rugby-union) or at
Rugby365, the South Africanbased site (www.rugby365.com/).
Even though the entire virtual world is now fully accessible to any-
one with an Internet-enabled device, people who live in different places
are, after all, still quite different in important ways. Culture and affinity
affect the ways in which you and I search the virtual world.
So, there you have it.
Location and gravity matter even though the travel cost (in this case
a few clicks) is, for all practical purposes, zero.

Washing Machines, Beer, and the Price of Mesothelioma

Weve already seen that what you search for online, and how often you
search, depends quite a lot on where you live. It turns out that what
sellers are willing to pay to be noticed via online ads when we do these
searches depends a lot on real-world factors too.
To get some feeling for this insight, lets reflect again on the real
world. Many of us (myself included) are quite used to feeling the effect
of local laws on our behavior. Local liquor laws, for example, can dictate
whether you can buy alcohol on a Sunday, or whether you can get a beer
from the supermarket.
If, like me, you live in a city like Philadelphia that charges sales taxes
on white goods, you might drive elsewhere (Wilmington, Delaware, in
my case) to buy your next washing machine or refrigerator. By doing so,
you can save a few hundred dollars. You feel good about the money in
your pocket and perhaps also that you thwarted the (Tax) Man.
For years people have been doing this throughout the United States
(and throughout the world in places where countries and states have
conveniently traversable borders) and for all sorts of products. Beer is a
notable category. Shoppers in Clarksville, Indiana, often cross the Ohio
River on Sunday to buy cold beer in Louisville, Kentucky.

19 Indianas Peculiar Liquor Laws May Drive You to Drink, editorial, Indiana Star, May
18, 2013, www.indystar.com/article/20130518/OPINION08/305180019/Editorial-Indiana-s-
peculiar-liquor-laws-may-drive-you-drink.

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Likewise, Diapers.com gets a boost in sales from locations with high

offline sales taxes. The reason? Until recently, shoppers in many states
could avoid paying taxes on online purchases. As a result, people liv-
ing in those states with high offline taxes made relatively more online
purchases.
These examples and those of our earlier discussion highlight that
there are times when each of us might free ourselves from the limits of
our physical locations. And while these examples have focused on phys-
ical goods, we see similar patterns for content as well. If youve driven
down Interstate 95 near Philadelphia recently (post May 2013) you
might have seen a billboard for (855) u-can-sue, hosted by the Philly
Legal Eagles.
Now, what if the Legal Eagles were unable to place their sign on I-?
(Some might say that would be a good thing.) Lets say that the state
did not allow lawyers to advertise. If they were barred from advertis-
ing offline in the real world, would they have to pay more online, in the
virtual world, to position their business online to reach some aggrieved,
would-be plaintiffs doing Google searches?
The answer is yes, they would.
Catherine Tucker from MIT and Avi Goldfarb from the University
of Toronto looked into this issue. They examined how much sellers in
different states (in this case attorneys) were willing to pay to bid on cer-
tain keywords to advertise their services. It just so happens that some
states dont let lawyers chase ambulances, i.e., try to contact people
who have recently experienced a painful injury or a wrongful death in
their immediate family.
Tucker and Goldfarb examined the prices bid for keywords in states
in which direct solicitation (through offline mail, for example) by attor-
neys for personal injury or wrongful death suits was prohibited. Then
they compared the prices in these locations with the prices that were
paid in states in which offline solicitation was allowed.

20 Jeonghye Choi, David R. Bell and Leonard Lodish, Traditional and IS-Enabled Customer
Acquisition on the Internet, Management Science, 58, no. 4 (April 2012), 75469.
21 The Philly Legal Eagles, Rizio, Hamilton & Kane, P.C., Debuting New Billboard Location
On I- May 13th, press release, PRWeb, May 9, 2013, http://www.prweb.com/releases/
prweb2013/5/prweb10716174.htm.
22 Avi Goldfarb and Catherine Tucker, Search Engine Advertising: Channel Substitution
When Pricing Ads to Context, Management Science 57, no. 3 (March 2011), 45870.

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Sure enough, in states in which lawyers faced offline restrictions, sell-

ers (lawyers) had to pay a lot more for terms like car accident, medi-
cal malpractice, and my all-time personal favorite, mesothelioma.
The overall price premium in those restricted states was perhaps
5 to 7 percent, which is really quite a lot. That is, attorneys would have
to pay 5 to 7 percent more online for those words than they would have
to pay in some other location where the offline billboards were allowed.

Inclement Weather, Social Networks, and WindSurfing

in Switzerland

Academic creativity was running high when researchers at Columbia

and Stanford Universities collaborated with a coauthor in St. Gallen,
Switzerland, and became interested in understanding how a real-world
phenomenon changes in the weather affected virtual-world activity
(posting on blogs and social networks) and ultimately created value for
sellers.
The authors collected their data from Soulrider.com, a Swiss wind-
surfing and snowboarding website with over ten thousand members.
They found that the most blogging occurred at times and locations
when there was more variation in wind speed in the real world i.e.,
they found that a real-world phenomenon drove activity in the virtual
one. The higher the speeds at a location, the more blogging that oc-
curred at that location so the geographic distributions of blogging
and windspeeds were positively correlated. More than that, however,
the authors found that social networks are subject to network effects in
content generation.
What does this mean, exactly?
This means that they found that this incremental blogging also led

23 This is often cited as one of the most expensive words one can bid on costing up to $140
per click in some instances.
24 Scott Shriver, Harikesh Nair, and Reto Hofstetter, Social Ties and User-Generated Con-
tent: Evidence from an Online Social Network, Management Science 59, no. 6 (June 2013),
142543.
25 As a former resident of New Zealand, a place with ample beaches that were immortalized
in the movie Endless Summer, I feel it a bit hard to come to terms with European surfing.
Nevertheless, the insights from the study are worth knowing about!

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to more friend requests, which in turn generated more blogging. So, if

a given user generated more social connections, then that user would
also generate more content. This creates a virtuous cycle of content cre-
ation and reciprocation, which can in turn increase the value of a social
networking site (SNS).
While owners of an SNS cant control the wind, this finding is benefi-
cial to sellers (in this case the owner of the SNS and the various clients
who may want to advertise on it) because it clearly shows that events in
the real world directly precipitate ties and content in the virtual one.

Summary

The real world puts obstacles in our way. Important information (e.g.,
about prices and product quality) can be hard to come by or costly to
obtain, and not all products and services are offered in all locations. The
virtual world helps us to overcome these search and geographic fric-
tions, often eliminating them entirely. However, the Internet sometimes
imposes frictions of its own by making us wait for delivery of things
bought online, or by making us uneasy about buying products with
touch and feel components.
So, the real and virtual worlds compete with and complement each
other. In the virtual world, you can get all the information you need
about a great espresso machine for your home you can check the price
and see that its in stock but you still might want to visit a real-world
store and taste the coffee before buying. You might begin your jour-
ney searching in the virtual world, and end it by shopping in the real
one.
If you live in Philadelphia, you can get all the rugby news you want
from either the Cape Town or the Sydney-based website. Even though
the travel cost of visiting either website is zero, you strongly prefer
the former site because its produced in a country that is closer to you.
Among all the findings weve reviewed in this chapter, I find this es-
pecially intriguing. Gravity still holds sway over the way we consume
content and information goods in the virtual world!
In chapters 1 (GEOGRAPHY) and 2 (RESISTANCE) weve laid the
foundation for why the real world is so important and for why and how

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the real and virtual worlds interact and compete to deliver goods, ser-
vices, and information.
The key to overcoming resistance is to understand all the ways con-
sumers are frustrated by frictions. The next part of the book section
A-V-I discusses how you and I learn about whats available virtually,
how we affiliate with others online, and how we liberate ourselves from
the deficiencies of our real-world locations.

Frictions frustrate in the real and virtual worlds youll succeed in both
when you identify and eliminate them.

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